5. You are considering the purchase of a quadruplex apartment building. Effectiv

Question

5. You are considering the purchase of a quadruplex apartment building. Effective gross income during the first year of operations is expected to be $33,600 ($700 per month per unit). First-year operating expenses are expected to be $13,440 (at 40 percent of EGI). Ignore capital expenditures. The purchase price of the quadruplex is $200,000. The acquisition will be financed with $60,000 in equity and a $140,000 standard fixed-rate mortgage. The interest rate on the debt financing is 8 percent and the loan term is 30 years. Assume, for simplicity, that payments will be made annu- ally and that there are no up-front financing costs.

Explanation / Answer

Part a)

The overall capitalization rate is calculated as below:

Overall Capitalization Rate = Net Operating Income/Market Price*100 where Net Operating Income = Effective Gross Income - Operating Expenses

Using the information provided in the question, we get,

Net Operating Income = 33,600 - 13,440 = $20,160

Overall Capitalization Rate = (20,160)/200,000*100 = 10.08%

_____

Part b)

The value of effective gross income multiplier is arrived as follows:

Effective Gross Income Multiplier = Market Price/Effective Gross Income = 200,000/33,600 = 5.95

_____

Part c)

To calculate the equity dividend rate, we need to determine the annual payment associated with the debt. The value of payment can be calculated with the use of Payment (PMT) function/formula of EXCEL/Financial Calculator. The function/formula for PMT is PMT(Rate,Nper,-PV,FV) where Rate = Interest Rate, Nper = Period, PV = Present Value and FV = Future Value (if any).

Here, Rate = 8%, Nper = 30, PV = $140,000 and FV = 0

Using these values in the above function/formula for PMT, we get,

Annual Debt Payment = PMT(8%,30,-140000,0) = $12,435.84 or $12,436

Now, we can calculate the equity dividend rate as below:

Equity Dividend Rate = (Net Operating Income - Annual Debt Payment) /Value of Equity*100 = (20,160 - 12,436)/60,000*100 = 12.87%

_____

Part d)

The value of debt service coverage rate is calculated as below:

Debt Service Coverage Ratio = Net Operating Income/Annual Debt Payment = 20,160/12,436 = 1.62

_____

Part e)

Step 1: Calculate Mortgage Constant

The value of mortgage constant is determined as follows:

Mortgage Constant = Interest Rate + Principal Payment for First Year/Value of Debt = 8% + (12,436 - 8%*140,000)/140,000 = 8.88% or .0888

_____

Step 2: Calculate the Largest Loan Amount

The value of largest loan amount is arrived as follow:

Largest Loan Amount = Net Operating Income/Minimum Debt Coverage Ratio*Mortgage Constant)

Using the values calculated above and information provided in the question, we get,

Largest Loan Amount = 20,160/(1.2*.0888) = $189,189.12 or $189,190

_____

Notes:

There can be a slight difference in final answer on account of rounding off values.

Related Questions

Navigate

• Browse (All)
• Browse 5
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.